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Stocks fell more than 1% last week on the continued parade of conflicting U.S. economic data as well as some renewed nervousness over Spanish bank finances. The market's second consecutive weekly drop marked the end of a strong third quarter, with equities returning a solid 6%.

While a report out Friday suggested Spain would need less money than expected to recapitalize its banks, the nation's finances stilled weighed on the U.S. market. Investors fear a possible downgrade soon from Moody's, which currently has Madrid at just one notch above junk status.

The Dow Jones Industrial Average fell 1% last week, or 142 points, to 13,437.13, while the Standard & Poor's 500 index lost 1.3%, or 19.48, to 1440.67. In the third quarter the index rose 5.7%, and it's up 14.6% year to date. The Nasdaq Composite dropped 2% last week, or 64 points, to 3116.23.

Friday the Institute for Supply Management said its Chicago purchasing manager index fell to 49.7 in August from 53.0 in July, weaker than expectations. Earlier in the week, second-quarter growth in gross domestic product was revised down to a 1.3% annual rate from 1.7%. Yet jobless claims fell sharply for the week ended Sept. 22, the Labor Department said last week.

The market's back to focusing on what's happening in the domestic economy, and "it's not rosy," says Malcolm Polley, president of Stewart Capital Advisors. The Chicago PMI is more indicative of what's really happening, he says: "It suggests a slow economy and one that can't gain speed." For both investors and corporate managers, the elections and the fiscal cliff loom large. "You can't plan for next year if you don't know the tax code, for example," Polley adds.

Marc Pado, who runs DowBull, an investment advisory firm, concurs. "Investors and companies are unwilling to invest. Uncertainty is holding us back," he says. "It's all about politics and how the next three months are going to go" with respect to the elections and any resolution of the fiscal cliff. In the short term, the market's likely to be range-bound until the elections, he adds.

UP NEXT WEDNESDAY is the beginning of the debates between President Barack Obama and Republican challenger Mitt Romney.

The Pain of Sequestration

The market views defense-spending sequestration as unlikely, but Lazard analyst Michael Lewis sees it as the most likely scenario short of a Republican election sweep. Potential drops in 2013 defense company revenue and EPS are listed below.

Since then, the group has partially discounted the risk of sequestration but not all of it, says Michael Lewis, a Lazard Capital Markets analyst. However, most of the investment community, he says, views sequestration as something that won't occur: "The feeling is, it's so bad that it won't happen."

But Lewis isn't as sanguine, and he's gone to the considerable trouble of attempting to handicap what 14 companies with Pentagon revenue stand to lose in sales and earnings per share in 2013 if sequestration were actually to begin Jan. 2. (See nearby table.) Lewis says sequestration is the most likely scenario short of a Republican sweep in the November elections, a prospect that seems to grow dimmer by the day.

Perhaps investors aren't as prepared as they think. At its most basic, sequestration means some $54 billion would come out of annual national-security spending, nearly all of that from the Defense Department.

Not every defense stock has performed directly in line with its sequestration exposure. Flir shares, for example, are down 22%, and some of that could be due to European sales exposure. But CACI is down only 2% even as it is more exposed. Lewis says its management has been executing well, and the company has a strong following among institutional investors.

Besides profits and losses from sequestration, the human element will be painful as well. Lewis says full implementation could eventually lead to job losses of 4% to 6%, or 26,000 to 39,000 workers, among the 14 major companies in the table.

That's going to galvanize legislators. Although Lewis expects sequestration, he tempers that view with a belief that the new Congress, faced with those layoffs, will probably come to some kind of budget agreement in the first or second quarter of 2013 that will supersede the automatic across-the-board cuts required by sequestration.

A Republican sweep, Lewis says, could lead to a quick bounce in defense shares. Short of that, however, once sequestration looks to be a certainty, the stocks, some of them already down, will most likely suffer another significant drop, he warns.

THE STOCK MARKET IS OFTEN CALLED a casino, and one of the newest and starkest bets available among large caps is
Transoceanrig 3.908355795148248%Transocean Ltd.U.S.: NYSEUSD15.42
0.583.908355795148248%
/Date(1481321007649-0600)/
Volume (Delayed 15m)
:
22089079AFTER HOURSUSD15.41
-0.01-0.0648508430609598%
Volume (Delayed 15m)
:
73656
P/E Ratio
4.923843280007664Market Cap
5514055855.76823
Dividend Yield
N/ARev. per Employee
545411More quote details and news »riginYour ValueYour ChangeShort position
(RIG). The global oil-services and drilling company has a market value of $16.1 billion.

Brazilian federal prosecutors served Transocean last Thursday with a preliminary injunction to cease operations there within 30 calendar days.
ChevronCVX 0.5557002691673179%Chevron Corp.U.S.: NYSEUSD115.81
0.640.5557002691673179%
/Date(1481320863217-0600)/
Volume (Delayed 15m)
:
5728292AFTER HOURSUSD115.81
%
Volume (Delayed 15m)
:
43259
P/E Ratio
N/AMarket Cap
217414357222.103
Dividend Yield
3.730247819704689% Rev. per Employee
1760670More quote details and news »CVXinYour ValueYour ChangeShort position
(CVX) was served as well. That move follows a drilling accident at the Frade offshore Brazil oil field last November that released less than 4,000 barrels of oil into the Atlantic.

Transocean said it "is vigorously pursuing the overturn or suspension of the preliminary injunction, including through an appeal to the Superior Court of Justice. Absent relief from the courts, Transocean will be required to comply with the preliminary injunction."

The bet here is whether Transocean's legal efforts will be successful against the prosecutors. The company has 10 rigs under contract for work in Brazil, which represented 11% of revenue for the first half of 2012. Analysts estimate that every lost month in Brazil will cost Transocean about 15 to 20 cents in earnings per share, at least until they redeploy the rigs.

Since Wall Street is looking for about $3 EPS this year and $4.59 next year, should Transocean have to shut down operations in Brazil for a stretch, it's going to hurt. Last year revenue was $9.1 billion.

Meanwhile, its stock, which closed at $44.89 Friday, fell 7.5% on the week and is down almost 50% from 2011 highs. Transocean still hasn't settled all the potential and substantial litigation involving the Macondo Gulf of Mexico well blowout and fire in April 2010. That has cost $4 billion so far in downtime, legal costs, and other knock-on effects. Transocean stock trades at a price/ earnings ratio of 15, a bit less than its historical median. Net debt stands at $9 billion.

Common sense suggests Transocean has a good chance of prevailing in Brazil. The penalty seems disproportionate to the spill. Both the national regulator National Petroleum Agency—which has said Transocean crews did nothing wrong—and government-controlled energy giant
Petroleo Brasileiro
(PBR) continue to support Transocean's efforts. (Transocean operates numerous rigs for the Brazilian oil giant.) Brazil needs to develop its huge deposits of offshore oil resources and to use the expertise of companies like Transocean.

But the cooler-heads-will-prevail theory has a flaw. The decision will be made by a court following procedures and laws and might not take account of the painful economic impact of Transocean's departure. The uncertainty is high.

For the short term, at least, this stock has become a speculative bet rather than a long-term investment.

Channing Smith, a portfolio manager at Capital Advisors, which has held Transocean shares for about a year, is guardedly optimistic that the company will prevail for all the reasons we've noted above. He thinks Transocean will rebound, but he also warns the Brazilian litigation could be a drawn-out process, and "that wouldn't be good for the stock…This is a stock with hair on it."

Institutional investors can afford to place a small bet on a Transocean rebound. However, widows and orphans and individual investors who are tempted might be better served by waiting and letting the Brazilian judicial waters calm. The risk of missing a nice 10% jump if Transocean gets the injunction suspended or lifted must be compared with another sharp drop if it is unsuccessful.

Moreover, should the company get clear of this mess, there will probably be another chance of further gains after the initial rebound.